Right Time To Enter The Capital Goods Sector?

Over the past 3 months, the BSE Capital Goods index is up by 30% compared to a mere 7% growth of the BSE Sensex. This gives a sense that the capex cycle in India is going to revive and the index is on its way up. Is this the right time to enter into Capital Goods stocks?

To answer this question, we need to look at some of the basic data which acts as lead indicators to forecast a revival in the capex cycle. First is the order inflow, which on the surface seems to have risen by 15% at the end of Q2FY12 on a yearly basis. However, if we exclude the orders of Capital Goods major L&T, which increased by 27% in the same time, it comes out to be just 1% for the entire sector. The second factor that we need to look at is the order book of these companies that fell by 1% on a yearly basis in the September 2013 quarter. Although a part of this fall may be attributed to order execution, it was also due to cancellations in order books of some companies. This has resulted into the order books remaining at an average of 2.1x of the revenue, almost flat on a month-on-month basis.

Another important data point that needs to be watched is projects data from CMIE (Centre For Monitoring Indian Economy), which showed a continued slowdown in new investments. New project announcements in the second quarter of FY14 fell by 2% on a yearly basis and stood at Rs 86100 crore, the 12th consecutive quarterly decline. It is not only the new announcements that have come down, but projects under implementation have also remained almost stagnant and are currently at level that they were seen at in 2004. The sales of Medium & Heavy Commercial Vehicles (M&HCV), another major indicator of industrial activity and capex cycle, is also not showing any sign of revival and the volumes fell by 25% in the 9 months ending September 2013.

Looking at all these facts, one will wonder why the Capital Goods index is moving up. There are two reasons for this. First, the BSE Capital Goods index is still down by 5% year till date compared to the BSE Sensex, which is up by 4%, so the current movement is more of a catch-up. Besides, many companies in the Capital Goods index like L&T and Crompton Greaves have a good presence outside India, and the situation there is improving. Hence, the stocks are rising, and therefore the index is too.

Nonetheless, there are some signs which show that things may change going forward. The country’s Gross Fixed Capital Formation (GFCF) saw a jump of 2.6 % in Q2FY14 after witnessing a consecutive fall in the last four quarters. Nonetheless, we need to wait for few more months before we see if these green shoots wilt or flourish. Although the government is trying hard to address various issues impacting the investment cycle like clearances, issues on fuel, land and environment, we believe it will take few more quarters before we can a see visible impact on the investment cycle.

In any case, we advise caution while entering these counters as of now.